Wednesday, July 21, 2010

Ben’s Curveball

Ben Bernanke threw a curveball today in his midterm report to Congress. The Fed view of the economy has been downgraded since its last report in February. This is not totally new news, since the June FOMC minutes reported this downgrade. However, “the majority saw the risks to growth as weighted to the downside.”

But here’s the disconnect. With no inflation and weaker growth, including stubbornly high unemployment, Bernanke mostly talked about an exit strategy that would shrink the Fed’s balance sheet by removing liquidity. This was the Fed’s bias last winter when the recovery looked stronger. Now that the recovery looks weaker, the stock market was hoping to hear Bernanke hint of an easier policy that would increase liquidity if necessary. Didn’t happen.

At one point today stocks were down 165 points, though they finished better, falling only 109 points. Gold fell $7 to $1,184, and the greenback rallied a bit. Bond rates continued to slide lower.

But I have a different view of this story. The Fed has injected $1.4 trillion of new money into the economy, of which about $1 trillion of excess reserves are unused and on deposit at the central bank. So, in other words, the economy has more liquidity than it knows what to do with. What’s the problem? All that excess money is not being used. This, I believe, is a fiscal problem, not a Fed problem.

Think of all the economic obstacles of spending, taxing, and regulating coming out of Washington. What should be done to spur growth? Keep tax rates down. And stop passing massive regulatory bills, like the bank bill Obama signed today.

What else? Reduce tax rates for large and small businesses across-the-board. Then speed up business investment write-offs for tax purposes.

In other words, since businesses create jobs, provide businesses with a new round of tax incentives. Reduce their capital costs and raise their investment returns after-tax.

With gold near $1,200 an ounce, the Fed has done its job and then some in providing liquidity. Easier tax rates, rather than easier money, would spur jobs and a faster recovery.

About Me

Larry Kudlow

Lawrence Kudlow is CNBC’s Senior Contributor. For many years, he was the host of CNBC’s “The Kudlow Report”. He is also the host of The Larry Kudlow Show, which broadcasts on Saturdays from 10am to 1pm ET on WABC Radio and is syndicated nationally by Cumulus Media. He is also a nationally syndicated columnist and a former Reagan economic advisor. CNBC's The Kudlow Report also airs on Sirius (ch.129) and XM (ch.127) weeknights at 7pm ET.